Is There a Canadian Farmland Bubble?

Quick quiz: what’s the best performing Canadian asset class over the last three years?

It’s not residential real estate, no matter how badly one of us has proclaimed there’s a bubble. House prices are up about 15% since 2011.

It’s not the TSX, or S&P 500. They’re up about 20% and 50%, respectively, excluding dividends. I’m not sure how the S&P 500 is Canadian, but I just typed it on a laptop. There’s no take-backsies.

It’s not oil, or gold, or any other natural resource. In fact, both oil and gold have gone down over the last three years, although the decline in the Canadian dollar has helped domestic producers.

Okay, enough teasing. This super-duper performing asset is Canadian farmland. Since 2010, farmland prices in Saskatchewan have gone up about 90%. An Ottawa area farmer interviewed by the Globe and Mail figures the value of his 6,000 acres has tripled since the great recession. Is that enough for a farmland bubble to have formed?

Okay, that’s a huge move. But maybe farmland was just fundamentally undervalued? We’ve all heard the demographic story of how all this land is needed to feed all those hungry babies you ladies keep churning out. World bellies are hungry for Canadian wheat. Plus, crop yields in the United States have suffered from extreme weather over the past few summers, which not only increases commodity prices, but also makes Canadian wheat more important on the world’s stage.

I don’t deny there’s a long term bull case when it comes to farming. I also think there’s a long term bull argument for China to surpass the United States as the world’s true superpower, but I wouldn’t invest a nickel directly in the country. There’s just too many risks – not only with valuations, but also with some, uh, shoddy accounting standards.

There are three main reasons I think there’s a Canadian farmland bubble. I already touched on the first, which is the huge price increases the sector has witnessed. Even between 2003 and 2008, prices across the country were up an average of 6% a year. When you combine the last 10 years together, you’re looking at huge price movements for farmland.

Sure, crop yields have increased, thanks to technology and better crop management techniques. But have yields really increased 200-400% over the last decade? I’m pretty sure that’s not possible. Farmers are increasingly paying huge premiums for land that has only increased production 10-25%. In my world, those numbers don’t add up.

Just like in residential real estate, price increases are fueled by one prevailing factor – low interest rates. Farmers are happy to load on the debt at this point, since borrowing to buy land at 4-5% is a steal compared to interest rates paid in the past.

Plus, farmers are flush with cash. 2013 was probably the best year ever for Canadian crop production. The second best year was probably 2011. Canadian farmers have won the weather lottery, so to speak.

Farmers have short memories, it’s practically a requirement in a business where one bad storm can wipe out a whole year’s work. Most people would throw up their hands and try something new after a couple of bad crop years in the row. It takes a special kind of person to go back and plant another crop.

But this strength can also be a farmer’s weakness. Recent memory is nothing but lollipops and rainbows. Crop yields have been fantastic, interest rates are low, and times are good. Wouldn’t you expand surrounded by these economic conditions? But unlike most other businesses, the weather doesn’t play a factor. Last I checked, we don’t control the weather.

I know a couple that sold the family farm. A recent Chinese immigrant met with them, and offered to buy the whole thing at some silly price. This practice is relatively common these days. The cash was likely put up by other investors in China, while the buyer was used because there are restrictions to foreigners owning Canadian land. This way, everyone gets around the law.

There’s more. Canadian farmers who abandoned the industry years ago to get into better paying jobs are starting to come back and try their hand at farming again. People so bad at farming that they once quit are getting back into it, all while buying farmland at record highs. Yeah, that’ll end well.

The couple that sold the farm? They got well over $500k for it. Immediately, the buyer offered to lease the land back to them for around $15k per year. That’s a cap rate of less than 3% a year, for those of you paying attention.

Farmland is a huge part of the retirement plan for Liquid Independence, who has two quarter sections of the stuff that he’s never set foot on. He has both of his pieces of land rented out to the same guy, who isn’t even paying enough in rent to cover the interest on the mortgage. Uh, I’ll just say that you wouldn’t catch me investing in something like that.

To summarize, we have an asset that’s had a huge price increase, that’s attracting all sorts of new money, is easily purchased because of low interest rates, in an industry that’s had some of the best times ever recently. If you can’t see why I’m skeptical, you should probably go read a different blog. Canada’s farmland bubble is very real.

8 Comments

Thanks for the mention 🙂 I share the same concern as you regarding the high valuation of Canadian farmland. The primary factor is the low interest rate environment for sure. The farm loan I have from TD is sub 4%, and will likely stay pretty low for the next few years because Ms. Yellen is a dove, and I doubt Mr. Poloz has the chutzpah to raise our rates before the U.S. moves on theirs. There’s also an absence of houses on most farms. Without a building that depreciates over time, the value of the property is calculated purely based on the underlying hard asset, land. I don’t know whether or not farmland is in a bubble, but I like the diversification it adds to my portfolio.

I’m curious — so you’re kind of betting that politicians will act the way you think and not raise interest rates which is essentially the only way you are able to afford those farms and not lose your shirt?

That’s even riskier than betting on the weather in my opinion. Humans are unpredictable, and politicians are even worse.

Yup, farmland is about 50% of my portfolio right now. I realize it’s a risky bet. I should be okay if interest rates rise slowly over a long period of time. The problem would be if rates rise too quickly, which I hope it wont lol.

From the sound of your comments, you make it sound like interest rates are the only factor that matter to farmland prices. I would disagree. I think all of the factors I illustrated in the post are important, and for the first time in a long time they’ve all come together. A couple of years of subpar yields could be disastrous for highly levered farmers.

Your negative cash flow position sums up my thesis nicely. Interest rates are about as low as they’re going to go, and you can’t even make enough to pay the interest with minimal expenses. When I bought real estate, I was making 10-12% after expenses. You need that buffer, or else you’re just speculating on price.

We are currently living that surrounded by farms and mango trees. Owning a farm is a little bit risky too, especially that “we don’t control the weather”, last year when the very strong typhoon Haiyan came and destroyed ALL the farms in our place. It was so heartbreaking to witness how they’re supposed to be the fruit of labors was vanished with just one blink of an eye.

I wonder if the difference between 90% in Saskatchewan and 300% near Ottawa is spill-over from the housing market: farmland near enough to cities to become subdivisions is no longer valued by the crops it could produce, but the housing units that could be built. Of course, the 90% is still a hell of a jump.

My understanding from the Globe article is that much of the gain has been driven by dairy farmers who have basically a license to print money because their quota is so lucrative. They’ve poured their profits back into land, leading to the drive up in prices.